SUPPORTING SALES AND OPERATIONS PLANNING THROUGH FINANCE INVOLVEMENT

Transcription

1 SUPPORTING SALES AND OPERATIONS PLANNING THROUGH FINANCE INVOLVEMENT Laskentatoimi Maisterin tutkinnon tutkielma Turkka Heinonen 2009 Laskentatoimen ja rahoituksen laitos HELSINGIN KAUPPAKORKEAKOULU HELSINKI SCHOOL OF ECONOMICS

2 HELSINKI SCHOOL OF ECONOMICS ABSTRACT Master s thesis, Management Accounting Turkka Heinonen SUPPORTING SALES AND OPERATIONS PLANNING THROUGH FINANCE IN- VOLVEMENT Research objectives Sources Research method Results The main objective of the research was to analyse how Finance can support sales and operations planning (S&OP). To support analysis of the main objective particular focus was placed on assessing how sales and operations planning can be coordinated, how financial forecasting can be integrated with S&OP and how performance measures can be utilized in S&OP. Theoretic part of the thesis comprises wide array of journals, articles, books and research regarding S&OP, financial forecasting and performance measurement. On the other hand, empiric data was gathered through conducting interviews at five manufacturing companies. The research was carried out as a descriptive and normative field study by interviewing ten (10) representatives from five (5) manufacturing companies. All interviews were recorded, transcribed and later validated with the interviewees. The research included analysing current practices and formulating improvement suggestions for each company by comparing the findings to theories. In addition, a comparative analysis of the identified practices was conducted. The research concluded that S&OP can be an effective way of coordinating functional planning activities and to support development of a common company-wide plan. It also concluded that Finance can support it by preparing financial forecasts in direct linkage to sales and operations plans as well as by establishing a S&OP scorecard and managing strategic measurement. Moreover, a comparative analysis of the companies resulted in a framework that can be used to assess Finance maturity in S&OP. In addition, each company were given suggestions to improve their current practices. Key words Sales and operations planning, S&OP, finance, accounting, financial planning, forecasting, performance measurement, scorecard, rolling forecasting 1

3 TABLE OF CONTENTS List of Figures 4 List of Appendices 4 1 Introduction Overview of sales and operations planning Research objectives Structure of the thesis Definitions 8 2 Insight to sales and operations planning Definition and objectives of S&OP Fundamentals of S&OP Demand and supply Volume and mix Alignment between strategic and detailed planning Process phases Data gathering and review Demand planning Supply planning Partnership meeting Executive meeting Effects of the process 20 3 Finance in S&OP Participation and role Financial reconciliation Frequency of financial reconciliation Content of financial reconciliation Strategic alignment Implications for budgeting and rolling forecasting Performance measurement General purposes of performance measurement Types of scorecards Review of performance measurement research Performance measurement in S&OP S&OP scorecard Theoretic summary 44 4 Field study Methodology Alpha Corporation 47 2

4 4.2.1 Company overview Execution of the research Current S&OP practice Financial forecasting and performance measurement Improvement suggestions Beta Corporation Company Overview Execution of the research Current S&OP practice Financial forecasting and performance measurement Improvement suggestions Gamma Group Company overview Execution of the research Current S&OP practice Financial forecasting and performance measurement Improvement suggestions Delta Group Company overview Execution of the research Current S&OP practice Financial forecasting and performance measurement Improvement suggestions Epsilon company Company overview Execution of the research Current S&OP practice Financial forecasting and performance measurement Improvement suggestions Comparative maturity model Interface between S&OP and financial forecasting Leveraging financial information in S&OP Frequency of financial forecasting Performance measurement Summary of company maturities 87 5 Discussion and implications Summary of the research Conclusions of the research Limitations and future research 92 Acknowledgement 95 References 96 Case material 102 Interviews 102 Appendix 103 3

5 LIST OF FIGURES Figure 1: Sales and operations planning connects detailed planning to business and strategic planning (adapted from Wallace, 2004)...13 Figure 2: Key linkages in sales and operations planning (Volman et al. 2005)...14 Figure 3: Summary of S&OP process (adapted from Dougherty & Gray, 2006)...20 Figure 4: Benefits provided by S&OP (Ventana Research, 2006)...22 Figure 5: Benefits of existing S&OP processes (Aberdeen Group, 2006)...23 Figure 6: Monetised sales and operations plan (Wallace, 2004)...28 Figure 7: S&OP as a medium for strategic alignment and execution feedback (adapted from Wallace, 2004)...32 Figure 8: The management system (Kaplan & Norton, 2008)...38 Figure 9: KPI Scorecard (Milliken, 2008)...43 Figure 10: Incorporating performance measurement and financial view into S&OP...44 Figure 11: Logic of developing improvement suggestions...46 Figure 13: High-level illustration of Alpha Corporation s S&OP process...50 Figure 14: Finance maturity in S&OP...81 LIST OF APPENDICES Appendix 1: S&OP literature summary Appendix 2: Management co control system package (Malmi & Brown, 2008) Appendix 3: Balanced Scorecard Approach for Sales and Operations Planning Measurements (Adapted from Palmatier & Crum, 2003) Appendix 4: Interview guideline Appendix 5: Acticity-based budgeting is ABC reversed (Cooper & Kaplan, 1992) Appendix 6: Monetized sales and operations plan (Dougherty & Gray, 2006) Appendix 7: Monetized sales and operations plan (Wallace, 2004)

6 1 INTRODUCTION 1.1 Overview of sales and operations planning Sales and operations planning (S&OP) is one of the most talked about and appreciated process topics in business today (Sheldon, 2005). Although the process has existed for over 30 years (see Sheldon, 2006 for a history synopsis), it has recently faced resurgence due to e.g. increased customer demand for faster response to market shifts and for more made-to-order products and services (Muzumdar & Fontanella, 2006). Consequently, S&OP has been in the headlights of many books, journals and magazines during the last few years (see e.g. Bower 2006 & 2005; Dougherty & Christopher 2006; Dwyer 2000; Galluci, 2008; Grimson & Pyke 2007; Harwell 2006; Lapide 2004, , 2005a, 2005b & 2007; Mentzer 2004; Olhager & Selldin 2007; Palmatier 2003; Proud 2007; Sheldon 2005 & 2006; Vollman et al. 2005; and Whisenant 2006). Traditionally many organisations have operated under central control, through functional departments (Kaplan & Norton, 2001). As a reflection, planning of sales, production, distribution and procurement are often made within each of the functional departments and independently of each other (Feng et al., 2008). This easily leads to sub-optimisation and neglecting strategic plans. The purpose of S&OP is to monthly tackle these issues through coordinating individual planning efforts in a business while also linking strategic goals to production (Vollman et al., 2005). It has been described as a set of companywide planning and decision-making processes designed to balance the supply of products or services with the demand for them and to link day-to-day operations with business goals, operational planning, and financial planning (Smith, 2008). Moreover, according to Bower (2005) using S&OP to provide visibility and monitor corporate strategy can enable enterprise-wide alignment and execution of an overall corporate strategy while on the other hand companies without S&OP have been argued to have a disconnection between the strategic and business (financial) plans and the detailed plans and schedules (Wallace, 2004). An efficient S&OP process is supposed to result in optimised inventory levels and increased customer service levels caused by higher product visibility (Mark, 2004). This is one of the reasons why the end phase of the process, often referred to as executive S&OP review, has been regarded 5

7 as one of the most powerful and influential meetings a company can hold (Sheldon, 2006). Based on the literature hype which has been partly illustrated here, it should be clear that a major practical interest in S&OP exists. On contrary, based on the discussions I have had with several management consultants, vast amount of companies still struggle even with the basics of sales and operations planning. This might come as a shock as balancing supply and demand should be just common sense to every business. Regardless of the vast amount of S&OP publications, there is a great lack of purely academic research (Grimson & Pyke, 2007). In fact, researches by Feng et al. (2008) and Grimson & Pyke (2007) are one of the rare concentrating purely on sales and operations planning. Also a few recent Finnish Master s thesis discusses the topic from implementation and process point of views (see Ravi, 2007; Saarinen, 2008). In addition to these academic researches, there are several studies conducted by organisations such as Aberdeen Group, AMR Research, Gartner, and Ventana Research. Due to the reliability issues with these commercial studies and lack of purely academic research there inevitably is great need for further academic research. Being Management Accountant, I will tackle S&OP through focusing on how Finance should support the process. In overall, literature implies two tasks that have generally been regarded as Finance s cup of tea. First, it has been argued that sales and operations plans should be converted into financial terms in order to make the plans understandable and to enable comparing them with business plan (Proud, 2007). Due to this aspect, S&OP has a strong connection to rolling forecasting which has had reasonable interest during the 21 st century by both practioners and academics (e.g. Hope & Fraser 1999, 2003; Hansen Van der Stede, 2004). Second, it has been argued that the value of the sales and operations planning functions is questionable if there s no monitoring of performance (Vollman et al., 2005) and that a well-balanced scorecard is an integral part of good S&OP process (Gartner, 2008). 1.2 Research objectives The main aim of the Master s thesis is to analyse how Finance function can support sales and operations planning. Viewpoint is on the input and output that finance should produce to improve S&OP and thus to better integrate marketing, operations and financial plans with strategic plans. 6

8 Existing academic research regarding these issues are limited. Although research on annual budgeting and rolling budgeting exist, they tend to focus on describing which practices companies are using rather than reasoning how they are using them. While discussing how Finance can support S&OP, issues relating to the integration of operational planning and financial forecasting and utilising performance measures in operational planning will be addressed both from theoretic and empiric point of view. To summarise, several interesting research questions are studied in order to support examination of the main research problem: 1. How can sales and operations planning be coordinated? 2. How can financial planning be integrated with S&OP? 3. How can performance measures be utilised in S&OP? The thesis has both descriptive and normative features. As descriptive case studies describe accounting systems, techniques and procedures currently used in practice (Scapens, 1990), the objective is to describe how companies included in the thesis currently operate S&OP and how do their Finance functions support it. On the other hand, the thesis is normative as it intents to define how each of these companies can improve their way of operating by comparing their practices to theories. Moreover, a comparative analysis of the current practices will be conducted through development of a maturity model regarding Finance support in S&OP. 1.3 Structure of the thesis The thesis starts with a literature review of sales and operations planning. For accountants this chapter aims at creating a more holistic understanding of distinct planning activities in a company. This is extremely important due to the fact that literature suggests that Finance should have a significant role in taking part and facilitating monthly company-wide planning activities rather than working within their own silos and maybe creating financial forecasting without any linkage to the plans that operations are developing. In general, describing the process consolidates many 7

9 sources of S&OP literature thus offering an overall picture and understanding. Finance related aspects of S&OP will be presented in the Chapter 3 which ends the theoretic part of the thesis. The research method will be presented in Chapter 4 which is followed by analysis of five manufacturing. The thesis ends with conclusions presented in Chapter Definitions Finance Finance is used as a synonym to finance and accounting function in general, thus including business controlling activities. Financial forecasting Financial forecasting is a process of estimating the expected financial results of the future. Financial reconciliation Financial reconciliation means the conversion of operational plans into financial terms. Sales and operations planning (S&OP) Sales and operations planning is a procedure that aims at keeping demand and supply in balance. It is a monthly or quarterly cross-functional procedure including planning over a horizon of approximately 18 months. (Adapted from Wallace, 2004) 8

10 2 INSIGHT TO SALES AND OPERATIONS PLANNING This chapter focuses on theories regarding sales and operations planning process in order to assure that an adequate understanding of the theme is perceived before going into discussing Finance s role in the process. The chapter starts by taking a look at a wide array of S&OP definitions and objectives, then moving into discussing the fundamentals of S&OP and its connection to strategic and detailed planning. Moreover, typical process phases of S&OP will be presented before discussing expected benefits of the process both from literature and research viewpoints at the end of the chapter. 2.1 Definition and objectives of S&OP As was presented already in the Introduction, S&OP has been described as a set of companywide planning and decision-making processes designed to balance the supply of products or services with the demand for them and to link day-to-day operations with business goals, operational planning, and financial planning (Smith, 2008). Although there is no single official definition of S&OP, the previous by Smith incorporates four important aspects of the process. First, the process goes beyond functional units. Second, in addition to planning it is a decision-making process as it may include deciding on discontinuing facilities or acquiring new ones. Third, it aims to balance demand and supply sides of the business by discussing e.g. sales and production plans collaboratively. Fourth, it is to implement the company strategy by placing a link between strategic planning and operations. Although Smith s definition incorporates important aspects of S&OP, it is it at the same time also very broad. Moreover, most pieces of S&OP literature are not able to give an unambiguous and detailed definition of the concept. According to Dougherty & Gray (2006) people may even use the term to mean many different things as some see it as a medium to long-term planning process while others might include also weekly planning into the picture. According to Grimson & Pyke (2007) planning horizons typically range from 6 months to over 3 years, but the most common horizon seems to be 6-18 months. However, they imply that the horizon varies by industry, by product seasonality, and by the time of year that S&OP planning occurs. Moreover, industries 9

11 that have long production lead times or high seasonality (apparel, pharmaceuticals, automotive products) will tend towards longer horizons, whereas short horizons will be more common in those with short lead times and low seasonality (commodity items) (Grimson & Pyke, 2007). Furthermore, some organisations, such as Gartner and AMR Group (2006), have added their own flavour to the definition game by beginning to talk about integrated business planning (IBP) as an extension to sales and operations planning (see e.g. Gartner, 2008; Aberdeen Group, 2006). In their opinion S&OP has not been able to do nothing but to balance supply and demand while failing in recognising strategy. Moreover, the value of using the term IBP can be questioned since for instance Grimson & Pyke (2007) support the strategic linkage of S&OP by saying: S&OP is a business process that links the corporate strategic plan to daily operations plans and enables companies to balance demand and supply for their products. (Grimson & Pyke, 2007) In addition, balancing demand and supply can also be executed in varying forms. Feng et al. (2008) acknowledge three different kinds of S&OP approaches which differ on the level and structure which planning is done. The most advanced S&OP is supply-chain based S&OP (SC- S&OP) that integrates sales, production, distribution and procurement. On the other hand, salesproduction planning-based S&OP (SP-S&OP) integrates sales and production planning while distribution and procurement planning is separated. The most unsophisticated structure is decoupled planning (DP) in which sales, production, distribution and procurement planning are all separated. In order to showcase more holistically how S&OP is discussed in literature, key elements of sales and operations planning from several selected sources have been summarized into a table presented in Appendix 1. The table presents how several articles, research and books have defined S&OP, what are its goals and project phases et cetera. As can be noticed from the summary table, the definitions are quite similar to each other whereas differences exist in the details such as the time horizon and functional scope as has been discussed above. This thesis sees sales and operations planning as a formalised monthly or quarterly process which integrates functional views of an organisation into a single and shared plan that ultimately should 10

12 drive strategy implementation. The key point here is that it incorporates several if not all functions of the company (marketing, sales, production, procurement, human resources, finance etc.) and aims at creating a common plan that everybody understands and agrees with. As Dougherty and Gray (2006) put it, S&OP integrates, synchronises and directs all of the detailed and functional planning efforts in a company, to ensure that they do not cause sub-optimisation or interference and that they are reconciled and mutually support overall company goals, especially strategic and financial plans. In contrast, if functions would develop their plans in silos, without cross-functional interaction, production would not e.g. be able to prepare for upcoming marketing campaigns that marketing function might be planning. It is clear that planning in silos could therefore lead to lethal actions for the company. Moreover, balancing supply and demand is not easy although it should be self-evident. 2.2 Fundamentals of S&OP Obtaining a better understanding of sales and operations planning requires looking at four fundamental factors that are often presented in literature when trying to scope and introduce the S&OP concept. These four fundamentals; demand and supply, volume and mix; will be presented below (see e.g. Dougherty & Gray, 2006; Vollman, 2005; Wallace, 2004) Demand and supply As already mentioned, one objective of S&OP is to balance demand and supply sides of the business (see e.g. Bower, 2005; Dwyer, 2000; Grimson & Pyke, 2007; Smith, 2008; Whisenant, 2006). If demand greatly exceeds supply, adverse effects might appear as customer service might suffer, sometimes leading to lost business; costs might increase with overtime and premium freight; and quality might sometimes decline as the company strives mightily to get products shipped. On the other hand, over supply might lead to cash flow issues and underutilisation of resources due to increased inventories as well as to squeezed margins due to attempts to increase sales by cutting prices. (Dougherty & Gray, 2006) It should be acknowledged that the optimal balance between the two variables is depended especially on the strategy of the company and the service levels it wants to offer. Moreover, excellent 11

13 service levels often requires not using assets to their fullest potential while it would probably negatively affect on service levels as there would be only little idle time to react to changes e.g. in customer behaviour. On the other hand, as Wallace (2004) points out future imbalance between supply and demand may be due to growing business and might be reflected in capacity addition discussions during S&OP Volume and mix The other two fundamentals of S&OP are volume and mix. Both Dougherty & Gray (2006) and Wallace (2004) argue that S&OP should concentrate on volume rather than mix since volume is the big picture and mix is the details. They present that volume deals with product families whereas mix with individual products. Moreover, it might be more rational to first assess e.g. if you even have the capacity to produce the planned volume before going in to the mix issues. In addition, Dougherty and Gray argue that many companies focus too much on the mix which in their opinion means overworking the details and not fully understanding the big picture. On the other hand, companies have found that when they do a good job of planning and re-planning volume (rates and levels) as they go through the year, them problems with mix become less difficult to deal with (Wallace, 2004). 2.3 Alignment between strategic and detailed planning According to Wallace (2004) companies without S&OP frequently have a disconnection between the strategic and business (financial) plans and the detailed plans and schedules that are used to run daily operations. In other words, he thinks that the plans developed and authorised by top management are not connected to the plans and schedules that drive day-to-day activities on the plant floor, the receiving dock, and the shipping dock. Furthermore, he agues that S&OP would link the top-level strategic and financial plans of the business to the week-to-week, day-to-day, or shift-to-shift activities of receiving and promising customer orders, acquiring material, converting it into finished product, and shipping it to customers. This linkage is presented in Figure 1. 12

14 Figure 1: Sales and operations planning connects detailed planning to business and strategic planning (adapted from Wallace, 2004) Although the straightforward comments by Wallace presented above might be exaggerating, there can also lie much truth in them. For instance many other pieces of literature present S&OP as an intermediary between strategic and detailed planning due its position in manufacturing planning control (MPC) systems. As can be seen in Figure 2 S&OP has been argued to lie in the middle of strategic, functional and detailed planning. Its purpose can be understood through analysing the figure and seeing it as a process that integrates marketing, resource, financial and demand planning into a common plan that also recognises strategic objectives of the company. In other words, it should tie the company s high-level business and strategic plans to the operations of each department (Proud, 2007). 13

15 Figure 2: Key linkages in sales and operations planning (Volman et al. 2005) According to Vollman (2005) the chain from strategic and operational planning to the execution gets generated when a linkage from S&OP to the MPC systems is created. He argues that the most fundamental linkage is that to the master production schedule that is a disaggregation of the operations plan. In more detail, he means that the operations plan normally stated in terms of aggregate units of output per month should be used as input when developing the more detailed master production schedule (MPS) which is stated in terms of end product units per week. Moreover, he mentions that the result drives the detailed scheduling through detailed material planning and other MPC functions. Due to the central role of sales and operations planning it is typically regarded as the highest planning level in a manufacturing planning and control system (Olhager & Selldin, 2007; Olhager et al., 2001). It should be noted that although S&OP is connected to MPC, the process of detailed production planning is not included in the S&OP process as was discussed earlier when describing the four fundamentals of S&OP. Moreover, Figure 2 is in line with the four fundamentals by stating that volume planning should be part of S&OP whereas mix decisions are carried out elsewhere but in connection to S&OP. Nevertheless, Palmatier & Crum (2003) empha- 14

16 size the linkage by stating that a fully integrated planning and control system should include both aggregate and detailed planning activities (Palmatier & Crum, 2003). To summarise, S&OP can bee seen as the driver, the windshield, the dashboard and the steering wheel whereas the detailed resource planning and execution systems of ERP and MRPII are the rest of the car, insuring the rubber meets the road in the right direction, in the right gear, and at the right speed (Dougherty & Gray, 2006). Furthermore, the S&OP methodology makes up the top end of the ERP business (Sheldon, 2006). 2.4 Process phases Many articles, books and research have addressed sales and operations planning process (see Appendix 1). Although the contents of S&OP project phases are quite similar to each other between different literature sources, there are some differences in how the tasks are categorised in separate process phases. The following chapters will present the phases mainly as they are described by Dougherty & Gray (2006). Moreover, it should be acknowledged that Wallace (2004) has described the process in a very similar way. The process comprises five phases which represent data gathering & review, demand planning, supply planning, partnership meeting and executive meeting as the final step of the process. Nevertheless, it should be acknowledged that especially many smaller companies combine pre-s&op meeting and Executive S&OP meeting (see e.g. Dougherty & Gray, 2006) Data gathering and review The first step of S&OP is basically just in place to prepare relevant information for use in other phases of the process. Much of the activity is claimed to occur within the information systems department. It consists of four elements: Updating files with data from the month just ended actual sales, production, inventories, and so on. Generating information for sales and marketing people to use in developing the new forecast. This could include sales analysis data, statistical forecast reports, 15

17 key performance indicators (KPI s) on demand, service level data, inventory levels and worksheets for field salespeople. Generating information for supply chain, planning and manufacturing people to use in reviewing and updating supply plans. This could include actual production and purchasing data, KPI s with respect to supply, capacity information and inventory numbers. Disseminating this information to the appropriate people. Often information is maintained at SKU level but since S&OP is about managing volume, this data is presented in a smaller number of S&OP families while the item-level mix will be managed by the detailed forecasting and master scheduling processes Demand planning The second phase of sales and operations planning deals with generating a baseline demand forecast for the offered products. This is where people in sales review the information they received from Data gathering phase, analyse and discuss it, and generate the new management forecast for the next twelve or more months. This forecast must include both existing products and new products so that the supply side of the business is able to make appropriate plans. According to Dougherty & Gray (2006) this helps to avoid painful surprises such as: not being able to meet revenue goals or financial commitments that were predicated on the new products impacting other existing product line, which may share critical resources or materials with the new product unplanned overtime and premium freight charges to rush the new product out at the last minute shortages and delays in getting the new product to customers, after it is been introduced to the marketplace 16

18 In addition, Grimson & Pyke (2007) and Mentzer & Moon (2004) present that the updated demand forecast must be unconstrained meaning that it only recognises the demand side of the business while any other constraints such as production capacity are neglected. Nevertheless, there should be a two-way connection between demand planning and supply planning already at this point at least because of two things. First, Mentzer & Moon (2004) argue that supply side employees can be invited to the meeting purely as observers. Second, Dougherty & Grain (2006) present that demand planning phase should include determining future customer needs and propose changes to inventory targets. According to Grimson & Pyke (2007) demand forecasts are usually best made in units and then translated into monetary terms in order to enable adjusting plans to meet the business objectives. Moreover, they argue that people from Finance should be involved in this to help the responsible managers compare, validate and reconcile the latest forecasts to the company s financial targets and plans. Due to these reasons Wallace (2004) presents that participation of Finance is very valuable at the demand planning phase Supply planning The first step in the supply planning phase is to modify the supply plans for any families or subfamilies that require it based on changes in the size of the customer order backlog, the sales forecast, inventory levels, or material and capacity available. Moreover, Wallace (2004) presents that changes in the sales forecast, inventory levels or the size of the customer order backlog can trigger a change to the operations plan. On the other hand, if everything has went according to plans there should be no reason to modify the plan made in the previous month rather than add one month at the end of the forecast. Outputs of the supply planning phase include a high-level supply plan (Mentzer & Moon, 2004), information on future capacity issues, including any impact of new product development trials, testing or sample production, on standard manufacturing resources (Dougherty & Gray, 2006) Partnership meeting The fourth phase of S&OP process is basically a meeting in which people from different functions get together to discuss and to form an integrated plan. Their job is to do a family-by-family 17

19 review of the updated sales and operations plans and to make adjustment, check for resource constraints and, where found, establish demand priorities by product, market and customer. This phase is often called with some other names as for instance Wallace (2004) calls it pre-s&op meeting in order to illustrate that its aim is to make preparations for the actual S&OP executive meeting. Objectives of this meeting include: discussing, challenging, and validating the demand and supply plans, and the assumptions that underlie them, making decisions regarding the balancing of demand and supply, reviewing progress on action items assigned in the previous meeting, resolving problems and differences so that, where possible, a single set of decisions or recommendations can be presented to the executive meeting, indentifying those areas where agreement cannot be reached, and developing, where appropriate, scenarios showing alternate courses of action to solve a given problem (for example, sales wants an immediate supply plan adjustment requiring premium air freight and overtime expense to preserve service level, while operations wants to phase in a capacity increase to minimize costs, using up safety stocks to keep the service level high), and setting the agenda for the executive meeting and determining how each issue will be presented Especially interesting from accounting perspective is that an updated financial view of the business is mentioned as one of the outputs of this meeting (see both Dougherty & Gray, 2006 and Wallace, 2004). This will be further discussed in Chapter Executive meeting During the executive meeting senior management offer direction, decision, prioritisation, and information to help resolve any issues or gaps (Bower, 2005). Ideally, they only review and approve the work from the earlier stages and grant authority to implement planning decisions (Grimson & Pyke, 2007). According to Dougherty & Gray (2006) its objectives are: 18

20 To approve or make decisions on each product family: accepting the recommendations from the partnership meeting team or choosing a different course of action To authorise changes in production or procurement rates, where significant costs or other consequences are involved To compare the dollarised version of this latest set of plans to the business plan and where they deviate, decide to: i. Initiate changes to sales, marketing, production, procurement or product development tactics and activities to bring the plans back in balance, and/or ii. Adjust the demand or supply plans, and/or iii. Adjust the business plan, as appropriate To break the tie for issues where the partnership meeting team was unable to reach consensus To review customer service performance, other critical KPI s, new product issues, special projects, and other issues and make the necessary decisions Summary of the S&OP process described in earlier chapters is depicted in Figure 3. 19

21 Figure 3: Summary of S&OP process (adapted from Dougherty & Gray, 2006) 2.5 Effects of the process Before going into the analysis of including Finance in sales and operations planning, expected effects of the process will be discussed. Moreover, it has been argued that balancing supply and demand should be self-evident and pure common sense to every company because it helps to utilise resources and potential to the fullest. The effects will be discussed both from theoretic and empiric viewpoints in order to offer a broad outlook into the discussion of S&OP effects. Due to the fact that profit optimisation has been presented as the main objective of S&OP (see Grimson & Pyke, 2007) it can be argued that S&OP should accelerate performance when operated well. Moreover, this may be achieved through better inventory management since according to Mark (2004) an efficient S&OP process is assumed to result in optimised inventory levels and increased customer service levels caused by higher product visibility. Moreover, according to Mentzer and Moon (2004) the goal of sales and operations planning is to meet financial goals 20

22 through iterating supply and demand which reflects that S&OP might lead to better utilisation of assets. Similar goals have been presented in other pieces of literature (see Appendix 1). Furthermore, another interesting argument supporting S&OP benefits is given by Sheldon (2006) who points out in his book that managers who have worked with S&OP processes in their past organisations are not willing to do without the advantage once they join new organisations. Very similarly to the effects described above, Bower (2006) presents in his article five typical value creation opportunities based on his experience with a diverse cross industry mix of clients. These opportunities are: 1. Improved forecast accuracy 2. Reduced inventory 3. Reduced obsolescence 4. Improved customer service/revenue creation 5. Improved portfolio management/new product introductions First of all, a key driver of improvement in forecast accuracy is supposed to be the determined effort of the S&OP team to bring data, assumptions, facts, and plan deviations to the demand review discussion. As a result, improved forecast accuracy helps to assure the availability of the right product, at the right time, and at the right place. Secondly, improving forecast accuracy will certainly aid in the reduction of inventory because employees attending supply review meeting will be able to trust to the demand forecast more. Thirdly, the S&OP process reduces inventory obsolescence in part by improving forecast accuracy and by the measurement of supply planning processes. Additional obsolescence reduction can be achieved by working a portfolio management review process under the S&OP umbrella in which e.g. the discontinued SKUs are determined. Fourthly, S&OP improves customer service due to better estimations on the needed level of safety stocks. In more detail, understanding the service level required by the customers is material through impacting the amount of inventory required. Fifthly, there is more focus in portfolio management providing more visibility to the promotional pipeline to assure that supply is 21

23 available, and to challenge the underlying assumptions driving the promotional forecast. (Bower, 2006) It seems that empiric research regarding the effects of S&OP support the ones presented in literature. Results of a study conducted by Ventana Research support the benefits discussed in S&OP literature (see Figure 4). Furthermore, improvements in forecast accuracy, customer satisfaction, asset utilisation and inventory value were the four most common areas where companies had gained benefits. Although the study might lack objectivity due to its commercial purpose, it provides extremely important and interesting background information for this paper. Besides, the research was carried out as a questionnaire which resulted in 470 qualified respondents of the 952 in total reflecting high answer rate and massive sample size. Area of improvement Inventory turns Gross margin 24 % 4 % 25 % 4 % Return on assets Perfect order Working capital 24 % 22 % 25 % 6 % 8 % 5 % Revenue 27 % 4 % Order fill rate 29 % 5 % Inventory value Asset utilization 33 % 32 % 4 % 7 % Customer satisfaction 29 % 10 % Forecast accuracy 36 % 7 % 0 % 5 % 10 % 15 % 20 % 25 % 30 % 35 % 40 % 45 % % of respondents Substantial Overwhelming Figure 4: Benefits provided by S&OP (Ventana Research, 2006) A research conducted by Aberdeen Group (2006) comprising more than 140 enterprises supports the findings of Ventana Research. These results are depicted in Figure 5. In more detail, vast majority of the respondents had gained improvements in forecast accuracy and better cross- 22

24 functional communications. In addition, remarkable portion of the respondents have been able to improve their inventory management. Area of improvement Gross margin Customer retention 23 % 23 % Lead-times Planner productivity Supply disruptions 29 % 33 % 36 % Stockouts Order fill rate Reduced inventory 42 % 46 % 48 % Communication between departments 61 % Forecast accuracy 67 % 0 % 10 % 20 % 30 % 40 % 50 % 60 % 70 % % of respondents Figure 5: Benefits of existing S&OP processes (Aberdeen Group, 2006) When comparing Figure 4 and Figure 5 you should keep in mind that the latter includes all levels of perceived improvements that were identified in the research whereas the earlier includes only substantial and overwhelming improvements. Nevertheless, their results robustly support benefits described in S&OP literature. The two research, which were just presented, illustrate that only few companies have been able to see improvements in profit-related metrics such as gross-margin. As Aberdeen Group (2006) points out this is most probably due to companies being able to progress in demand and supply matching but inadequate in doing it cost-efficiently. Another reason for this could be the lack of aligning sales and operations planning with financial goals of the company. This might result in optimising individual KPIs such as inventory measures instead of recognising strategic aspects of the company and therefore leading to conciliatory profit improvements. If this point of view is valid it certainly supports including Finance in the process. 23

25 More discussion of S&OP effects can be found from e.g. Dwyer s article (2000) which presents a company that improved its inventory accuracy from 64% to 98%, supplier delivery from 62% to 95% and manufacturing performance from 62% to 95%. In addition, an academic research by Grimson and Pyke (2007) analysed the interrelation between S&OP advantageous and firm size in order to study if S&OP more practical for sizeable organisations. Despite the small sample size of the study, it discovers that there is no apparent link between S&OP maturity and firm size. Another academic research regarding the effects is presented by Feng et al. (2008) who conducted an academic case study that evaluated benefits of well functioning S&OP by comparing financial performance of the case company in three different scenarios based on S&OP sophistication under seasonal demand and market price conditions. The simulation research concludes that the most advanced S&OP provided superior performance to the other scenarios. To summarise, it seems that companies with a S&OP process have been able to gain benefits especially regarding forecast accuracy and inventory management. Nevertheless there seems to be still much space for improvements as only small proportion have reported improvements in financial based figures. Moreover, according to Ventana Research 65% of companies have been doing sales and operations planning for less than 5 years which reflects that many companies might still be implementing their processes. 24

26 3 FINANCE IN S&OP This chapter focuses on Finance s role in sales and operations planning process through reviewing existing literature whereas empirical implications will be analysed later in the thesis. As was already mentioned in Chapter 2.4 Finance is argued to have a significant role in S&OP process since it is needed to better understand the financial impacts of the sales and operations plans (Wallace, 2004). Moreover, it was mentioned that S&OP involves reviewing the key metrics. Since understanding the consequences of measurement structure has been regarded central to accounting scholarship (e.g. Kinney, 2001), Finance clearly has a significant role also regarding performance measurement in S&OP. 3.1 Participation and role When discussing how Finance can support S&OP, an inherent starting point is to analyse what role and in which phases Finance could participate in S&OP. Moreover, if it is not included in the process at all, it becomes impossible to robustly support it neither. It has been presented that a mature S&OP process should be led by Finance people in order to ensure that the plans reflect the needs of the stockholders (Dadmun in Parker, 2008). On contrary, many other pieces of literature present that there is no common rule for who should be nominated as the S&OP Leader. For instance, Wallace (2004) mentions that it is best to select S&OP process owner and executive champion from different departments in order to avoid sending a message of a process that belongs only to a certain business function. In addition, he presents that S&OP has been led in real life by Director of Sales Administration, Demand Manager, Supply Chain Manager, Materials Manager, Controller, Sales Manager and Materials Manager. Although there is no certainty who should lead S&OP, it is by far a common view that Finance should be included in the process (see e.g. Wallace, 2004; Dougherty & Gray, 2006; Grimson & Pyke, 2007). Furthermore, when key Finance staff members are involved in the process, they are supposed to provide actionable data that makes it much easier to promptly shift away from a less profitable product (Mentzer & Moon, 2004). 25

27 In addition to theories, also empiric research seems to support the view of including Finance in S&OP. In fact, Ventana Research (2006) concludes that 42% of all companies include Finance in their sales and operations planning process. The finding that less than half actually do this seems relatively low compared to the vast amount of S&OP literature that supports including Finance in the process. Nevertheless, interesting is that the same study reports that 90% of companies with overwhelming gains in revenue did include Finance in their process. Although this seems very promising as it implies that including Finance in S&OP would improve the process, it should be acknowledged that only 4% of all companies under review reported overwhelming revenue gains meaning that the sample size for the category is as low as 19 companies. In addition, 70% of companies reporting gains in gross margin, 56% reporting gains in forecast accuracy and 76% reporting gains in customer satisfaction included Finance as part of their S&OP process. It must be acknowledged that the research is not able to prove that including Finance in the process was the only reason for the reported improvements in these performance indicators. Moreover, it could be argued that the ability to include Finance in S&OP reflects sophisticated procedures in general, thus resulting in a positive performance gap compared to other companies. On the other hand, mere Finance participation does not guarantee performance improvements whereas it depends on the impact it brings to the process. The following chapters will therefore focus in more detail on the things that Finance is supposed to support in sales and operations planning. 3.2 Financial reconciliation Unlike the overall business plan of the company which is stated in financial terms, S&OP is argued to speak in the language of sales and manufacturing: forecasts, bookings, production, units, hours, and so on (Proud, 2007). According to Lapide (2007) Finance s natural role in a S&OP process is to tackle this challenge through monetising the demand and supply plans developed by others so that everyone can see the future financial picture vis-à-vis the financial plans and budgets in place. In addition, also many others such as Dougherty & Gray (2006) argue that S&OP should include financial reconciliation. In fact, Ventana Research (2006) concluded in their research that alignment of financial plans with sales and operations plans is the single most significant factor contributing to performance improvement among companies running S&OP. In con- 26

28 clusion, the main reason for suggestions to convert sales and operations plans into financial terms seems to be to enable reviewing S&OP with the overall business plan of the company Frequency of financial reconciliation On contrary to doing financial analysis on an ad-hoc basis, theories imply that financial reconciliation should be a formal part of S&OP process (see e.g. Proud, 2007). However, providing just one view of the sales and operations plans does not necessarily satisfy the decision makers who often might want to see the expected effects of e.g. changes in raw material prices. Willingness to prepare such scenarios is most probably gaining much more interest as a consequence of the ongoing global financial crisis. For instance, Dougherty & Gray (2006) present that some companies maintain a standard high-low planning practice that enables either making contingency planning or at least better monitoring of the highest possible, lowest possible or most likely scenarios. In other words, scenarios can be developed in order to enable reacting proactively to possible disruptions in plans. While scenarios support risk management, monetised scenarios are also argued to accelerate performance optimisation through creation of several comparable plans. Muzumdar & Fontanella (2006) emphasise this by writing: S&OP is no longer just about balancing supply and demand. It is about searching for and executing the most profitable strategy out of many possible scenarios. The next chapter will focus more on the content of financial reconciliation Content of financial reconciliation The fact that literature suggests focusing on product family level in S&OP (see Chapter ) does not mean that financial reconciliation should be based only on product family level information. In contrast, necessary details should be available for financial reconciliation since sales and operations plans are usually first prepared at SKU level and only afterwards aggregated to product group level for reviews in S&OP meetings (see e.g. Dougherty & Gray, 2006). Put otherwise, S&OP incorporates detailed view into the plans although management focus is directed on more aggregated levels. 27

29 Many publications give real-life examples of monetised S&OP reports. It seems that most often they include the following items separately for each product family: sales revenue, gross profit and value of inventory (e.g. Harwell, 2006). For instance, a report of this kind by Wallace (2004) is depicted below in Figure 6 and a very similar one by Dougherty & Gray (2006) in Appendix 6. Figure 6: Monetised sales and operations plan (Wallace, 2004) Noteworthy is that S&OP literature suggests monetising also inventory values in addition to sales and operations costs. Moreover, being able to predict inventory levels and their value enable to assess working capital requirements of actualising the plans. Some companies go way beyond gross profit level as they fully integrate S&OP with financial forecasting and thus monthly prepare a completely updated financial view of their businesses. For instance, two case companies in Dougherty & Gray s (2006) book operate in line with this prac- 28